If tax rate Tc increases while other variables constant, what happens to WACC?

• A. WACC increases
• B. WACC remains the same
• C. WACC decreases
• D. WACC becomes negative

Answer: (D)

Raising the corporate tax rate increases the value of the interest tax shield. The after-tax cost of debt is Rd*(1−Tc); as Tc rises, this term falls, so the debt portion of the WACC becomes cheaper. Since WACC is the weighted average of the after‑tax cost of debt and the cost of equity with the same financing mix, a lower debt cost pulls the overall WACC downward (assuming there is some debt). If the firm is financed entirely with equity, WACC wouldn’t change with Tc. In general, with debt present, the WACC decreases.